Bond Outlook January 7th


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Moving from overpriced government bonds to quality corporates, our recommendation last October, is now commonplace. The Madoff scandal has very negative implications for New York and for hedge funds.

Bond Outlook [by bridport & cie, January 7th 2009]

The recommendation we began making as early as October last year to move into high quality corporate bonds, mainly industrial, has now become common currency, even being a front-page recommendation of the Financial Times yesterday. As spreads on such bonds have already tightened significantly, much of the potential has already gone. Nevertheless corporate bonds remain the most appropriate home for the proceeds from sales of government bonds, whose bubble-qualities remain. We can but repeat our position that profit-taking on government bonds makes sense.

In their search for corporate bonds, our clients are also expressing interest in convertibles. On the face of it, this reflects a sense that stock prices could stage a rally. In reality, however, it is only a way of finding corporate bonds with an acceptable yield, as most convertibles were issued before the crisis, with conversion prices which have little chance of being reached. Bond markets have started the year with poor liquidity. Market makers seem very much at sea, in the sense that they are finding it difficult to set prices, even on government bonds, never mind corporates.

There were several corporate issues at the end of 2008, and the signs are that 2009 is seeing a continuation of corporate issuance. In addition, in this first trading week of the year, some governments are also issuing, namely Brazil and Colombia. We expect many more issues from governments to finance their stimulus packages. If the maturities are long enough, the effect will be to steepen yield curves, which is a desirable objective, but during the current government hiatus in the USA no clear trend in maturities is likely. There will however come a point when the yield on long-term government bonds rises enough to make such bonds attractive in yield terms (as distinct from being only a quality refuge).

“We are all Keynesian now” reflects the view that there is no alternative to avoiding a depression other than massive deficit government budgeting and expenditure on infrastructure projects, with tax reduction playing an important secondary role. There is however cause for concern about applying more of the same “medicine” which caused the crisis in the first place. Our long-held view that Greenscam caused the problem by never allowing natural adjustment after bubbles burst (and indeed letting the bubbles grow in the first place) is now “received wisdom”, as is the idea that the US economic growth depended not so much on consumption but over-consumption. His “medicine” was cheap money and plenty of liquidity. The major difference with today’s policies is that the private sector remains slow in taking up the offer of cheap money, be that to invest or to spend, so government has to become the big spender. If this approach fails there is no “Plan B”, and if it succeeds we can but hope that the deficit spending can be cut fast enough to avoid a new bubble. For the moment the new corporate issues look destined for balance sheet clean-up and refinancing at lower cost.

We are observing a strange phenomenon, which may be the beginning of a trend, or may be but a temporary aberration. Instead of underwriting syndicates committing to a given issue size, they are “printing what they can sell”. i.e. obtaining orders in advance, and issuing, if necessary, additional tranches if take-up is better than expected. That implies, of course, that the issuer could have achieved a lower coupon cost and begs the justification of underwriting fees.

It is hard to imagine a financial centre and its regulatory system looking less trustworthy than New York’s. The evidence to date is that the SEC was explicitly warned as long as ten years ago, and at regular intervals since, that the Madoff structure and performance were suspect. The Wall Street banks themselves avoided him, leaving it to foreign banks and charities to lose their money in his fraudulent scheme. Hedge funds were already playing with the idea of recommending independent administrators, already practised in Europe, but not in the USA. It will soon also be US practice, as hedge funds without such independent oversight are blackballed. We continue to hope that the new US Administration will be able rebuild the trust and respect that the USA once enjoyed. Anecdotally, we note that according to the British press Americans living in the UK are receiving compliments from the British public and no longer have to qualify their nationality by adding “but I don’t support Bush”!


(!) Automobiles: Toyota closing its factories for eleven days. GM to receive additional aid of USD 5.4 bln from the Treasury

(–) UK: house prices fell by 2.50% in December, -15.90% compared to the previous year, the largest fall year on year

(?) Germany: Commerzbank plans to issue a government-guaranteed bond this week (EUR1-2bln) to fund its takeover of Dresdner Bank.

(?) Romania: the Central Bank leaves its benchmark rate at 10.25%

(–) USA: the bubble created by the issuance of so much government debt is illustrated by the gap between money supply (+15%) compared to 2008 GDP growth of 4%

(+) positive for bonds (–) negative for bonds (!) watch out (?) begs the question

Recommended average maturity for bonds.

Allow the slight shortening implied by the change of year, and prefer corporates over government.






As of 8.10.08





As of 16.07.08





Dr. Roy Damary